Richard Kinder streamlines empire to target midstream rivals

HOUSTON (Bloomberg) -- Billionaire Richard Kinder is consolidating his pipeline empire to strengthen it for growth as the U.S. shale drilling boom opens up $1.5 trillion in potential purchases and expansion projects.

Kinder Morgan Inc. plans to acquire all of Kinder Morgan Energy Partners LP, Kinder Morgan Management LLC and El Paso Pipeline Partners LP in a series of transactions valued at about $44 billion.

The move by Kinder, who controls the entities through his 24% stake in the parent company, runs counter to the industry trend of spinning off pipelines and oil terminals into tax-advantaged partnerships that funnel cash to investors. By simplifying his empire’s corporate structure, Kinder will lower borrowing costs and unify the company under a single stock that he can use as currency to buy competitors.

The consolidation will make it easier and more profitable for Kinder “to pursue expansion and acquisitions in a target- rich environment,” the company said in a slide presentation published on its website yesterday.

Investors have been putting pressure on Kinder, 69, to consolidate, cut costs and increase profits. Kinder Morgan Partners, the main operating unit, has been forced to buy into riskier, lower-profit businesses, such as oil tankers, because of its higher cost of capital, analysts with investment bank Tudor Pickering Holt & Co. said in a note to investors last month.

Management Fees

Kinder also has been criticized for the large amount of fees it paid out to his partnership management, among the highest in the industry, making it more expensive to finance growth.

The value of Kinder’s personal holdings in his namesake company surged by $1.55 billion after he announced plans to consolidate his corporate empire and accelerate expansion. Kinder’s 243.1 million shares in Kinder Morgan Inc. make him the largest individual investor in the Houston-based energy infrastructure company. The stock rose as much as $6.37 to $42.49 when trading opened in New York today, before slipping to $39.04, an 8 percent increase, at 10:13 a.m.

Concerns that Kinder may have trouble being able to make deals that immediately add to earnings, plus “a deteriorating business mix have been major factors in three-year under- performance across the complex,” according to the July 16 Tudor Pickering note.

Kinder has lagged rivals such as Williams Cos. and Enterprise Products Partners LP during the past three years, generating a 73% total return compared with 221% for Williams investors and Enterprise’s 130% return.

Takeover Targets

The move signals a new round of dealmaking for the pipeline industry, which has seen growth rocket in the past five years as the shale boom has spread across North America, creating demand for more pipes in new locations to ship oil and gas to markets. The number of partnerships has multiplied rapidly because of demand from investors for cash payouts that beat debt yields.

Looking ahead, Kinder’s potential acquisition targets include more than 120 energy MLPs that have a combined enterprise value of $875 billion, according to the company’s website presentation. The pipeline giant also has ample room to grow through new projects as expanding shale exploration and production spurs the need for $640 billion in new pipelines and storage tanks through 2035.

Diversity Important

Companies need a geographically diverse portfolio of assets across an array of oil and gas products that can weather slowdowns in individual sectors or regions, Kelcy Warren, the billionaire chief executive officer of Energy Transfer Partners LP, said last year.

Energy Transfer, the owner of 35,000 mi of natural gas pipelines, announced a deal in April to buy gasoline-station owner Susser Holdings Corp. for about $1.8 billion. Warren also was reportedly negotiating to buy Targa Resources Corp. for as much as $15 billion before the talks were scuttled, according to a statement by Targa in June.

Last month, Hess Corp. announced plans to separate railcars, trucking and storage facilities in North Dakota’s Bakken shale region into a master limited partnership. Investors rewarded New York-based Hess by pushing the shares to a five- year high on July 30.

KMI Surprise

The surprise in the restructuring is that Kinder decided to consolidate the companies under the corporate parent instead of making it one, giant partnership that would continue to benefit from the tax structure of so-called master limited partnerships. In its note to investors, Tudor Pickering had proposed the partnership buy its parent, Kinder Morgan Inc., instead of vice versa.

Although the proposed combination will eliminate the partnership’s tax-free status, the arrangement will confer other tax benefits on the parent company, reducing income tax liabilities by about $20 billion over 14 years, according to the website presentation.

The merger of the Kinder siblings, expected to be finished by the end of this year, will create the largest energy infrastructure company in North America with an 80,000-mi network of pipes that together would be long enough to circle the Earth three times.

Kinder, who co-founded the company in the 1990s with cast-off assets from Enron Corp., helped pioneer the MLP structure, which doesn’t pay federal income tax.

Big Payday

MLPs trade in units rather than shares. Holders of Kinder Morgan Partners and El Paso will have the option of taking cash or KMI shares in return for their units, according to the statement. The transactions are comprised of $40 billion in parent company equity, $4 billion in cash and $27 billion in assumed debt, according to the presentation.

Kinder plans to raise its 12-month dividend by 16% next year to $2 a share and to raise the payouts by 10 percent annually through the end of the decade.

Kinder, who takes a $1-a-year salary and earns no annual bonus from any of the four companies, will see his annual pay from dividends increase by more than $100 million thanks to the deal, according to data compiled by Bloomberg.

Beginning in 2015, Kinder will earn almost $500 million a year from the $2-a-share dividend he’s pledged to investors as part of the deal. That amount is based on the number of shares he will have in the combined company after the transaction, assuming he takes cash payments in lieu of additional Kinder Morgan Inc. shares. That compares with the $380 million he received last year from payouts by all four entities.

Kinder Morgan Inc. paid about $23 billion to acquire El Paso Corp in May 2012 in what was then the biggest-ever U.S. pipeline deal. In February of this year, Kinder Morgan Energy Partners paid $962 million for a fleet of crude tankers from entities controlled by Cerberus Capital Management LP and Blackstone Group LP.

The tanker deal was less than a year after Kinder Morgan Energy paid $4.1 billion for Copano Energy LLC, a pipeline operator in shale formations from south Texas to central Oklahoma.